The Road to Fiscal Union in the Eurozone?

In spite of the annual August lull, September – with the Dutch election, the troika’s verdict on Greece and the German constitutional court ruling on the legality of the European Stability Mechanism – always promised to snap the continent’s politicians out of their sun and sangria-induced stupor.

In anticipation of these potentially destabilising events, and the growing storm of unease over the state of Spanish and Italian public finances, the European Central Bank sent markets its strongest signal yet that it is
apparently potentially willing to deploy unlimited monetary muscle to save the Euro. ‘This is your bazooka’, suggested the OECD’s chief of Mario Draghi’s bond buying programme. In this carefully calibrated balance between the economic and the political, the onus now rests firmly with national governments.

Which is why, regardless of this shot in the arm from the ECB, a final resolution of the Eurozone crisis is unlikely to come either this month or any time soon. Summit after summit, crisis meeting after crisis meeting over the past three years, demonstrate that Europe’s main actors can get away with doing just enough to get through the next phase before mar Save kets strike again. To date this has worked in keeping the cart from running off the tracks, but for so long as growth remains elusive then the price will be long term stagnation. Indeed arguably underwriting Italian and Spanish bonds for the next two or three years only stacks up bigger problems for the future unless almost heroic levels of economic growth return.
This period of flat-lining may buy politicians the time necessary to convince electorates continent-wide that greater political and fiscal union is a price worth paying for economic relevance in a globalised economy.

But the whole structure of EU economic health could unravel much faster, perhaps beyond even Germany’s power to control, as markets lose patience with successive failed attempts by European leaders to deliver a lasting solution. At its most extreme this might lead either to the breakup of the Euro in the event that Germany repeated refuses requests to do ‘whatever it takes’ or the rapid introduction of more credible and lasting solutions such as the collectivisation or mutualisation of historic and future debt. How the people of Europe react to the latter scenario, when they wake up to the political illegitimacy of fiscal union, is the great unknown. Responding to the ECB’s bond-buying programme, Der Spiegel this week concluded: ‘The euro may be irreversible, but apparently democracy is not’.

What would such fiscal unity mean for the European Union as a community beyond the Euro of 27 member states?

In the United Kingdom – where I represent a constituency that contains the City of London, our famous financial district – there has been enormous complacency. The break-up of the Euro – which would undoubtedly inflict significant short term pain on the City – remains the British government’s greatest immediate fear. Forget triumphalism about the UK staying out of the single currency. Britain’s key trading partners remain European. If they suffer, so too does the forlorn hope of export-led growth. This summer’s dire trade figures already demonstrate just how vulnerable the British economy is to continental storms. Politicians at home have found it impossible to squeeze out any growth in the absence of any real domestic or international demand. Even the Asian and South American economies, which the UK has been so slow to exploit, show signs of a sharp downturn.

Nevertheless, the greater existential threat to the City and the UK surely comes from a successful banking and fiscal union. The complacent view from Whitehall is that any such emergency development would act to ringfence the Eurozone’s weaknesses. That might well be the case in the event that there was fiscal union amongst all of the Euro’s current members. It would be very hard to see, for instance, how the fundamental dearth of competitiveness in states like Greece could possibly be addressed if the Eurozone remained seventeen ‘strong’.

Yet fiscal union in the Eurozone would still represent an almighty challenge to an EU member state like Britain. History teaches us that an economic crisis is often regarded as too good an opportunity to waste for ambitious statesmen seeking to impose a wider political agenda. Recent talk of a transaction tax to be applied throughout the EU to help underpin the Eurozone’s finances would likely represent only the first such salvo. We have already seen too a land grab by the Paris-based European Securities and Markets Authority, which may start sabre-rattling when it comes to the question of which financial entities and products pose systemic risk. To hope that the UK would have any real clout in an EU with fiscally-integrated Eurozone members would be hopelessly naïve. The City of London is only too aware of the risk of losing business from regulatory arbitrage, having benefited so handsomely in the past from US regulatory clampdowns on Wall Street. There is also the not insignificant benefit of the UK’s ‘safe haven’ status. The UK’s continued colossal public borrowing has been at historically low interest rates. However, a successful Eurozone fiscal union would surely have the effect of diluting the UK’s safe haven status in the international gilts markets. We can expect a significant rise in our domestic interest rates.

A far greater threat still to the UK – and to all those member states not within the single currency – would be tighter fiscal and banking union amongst a core of EU members. Liberated from the dead weight of Greece and Portugal, for example, it would be hard to imagine that the institutions, supervisory and regulatory rules of a strong core would not begin to impinge on the economies of non-Eurozone member states. In the UK at least – a nation always inherently sceptical of the European project – the domestic case for the Britain’s continued membership of the Union would become increasingly unsustainable and unpopular, particularly if closer political and economic integration amongst that core came at the expense of the Single Market, not least in financial services. It would surely only be a matter of time until the choice would be put to the electorate that we either join the core in currency union or leave the European Union altogether.

Barely two year and a half years into this parliament, Britain’s coalition government has already had to address bubbling resentment over a host of EU-related issues. Fierce debate has been waged over the mount the grossly-indebted UK Treasury should contribute to bailing out European partners. Hostility to judgements by the European Court of Human Rights, while unrelated to the European Union, have nonetheless been conflated by the British media with broader disgruntlement towards supranational organisations. And the Prime Minister scored one of his greatest ever public relations victories when he refused to sign Britain up to the EU’s fiscal compact last autumn.

The case in favour of Britain’s membership of the European Union will hold so long as the UK electorate perceives its economic interests to be served by it. The moment that the economic case diminishes, we should not be surprised if a clamour for Britain’s exit from the EU quickly follows. In the meantime, we ought not be surprised if British domestic grandstanding has a significant impact on diplomatic relations with our fellow member states, risking a self-fulfilling prophecy as Britain’s ability to influence in its favour the outcome of the Eurozone crisis and the future direction of the Union declines as a result.

And what of the futures of any ejected Eurozone members in the event of a smaller, fiscally-integrated core? The popular anger that would be felt towards the European project in an ejected Greece, Portugal, Ireland or even Spain would not be salved entirely by generous economic development packages upon exit, even if there was no appetite in those countries for leaving the safety of the Union.

We can conclude only this: that European leaders can decide whatever they wish at summits and conferences. The greatest unknown for us all is the politics. Mario Draghi can provide the bazooka of support from the European Central Bank and appears for now to have the tacit support of Angela Merkel. But will the German people, with their historical, deep-seated fear of printing money, accept the liabilities of a continent? Will the electorates of debtor nations accept swingeing austerity and fiscal rectitude as the price of inclusion in the grand European project? And could a fiscally-integrated core of EU member states be reconciled with a broader and looser Union of 27 member states?

For some time, well before the advent of the Eurozone crisis, the European Union had been suffering a dearth of political legitimacy, the consequences of which were kept at bay by steady, if underwhelming, economic growth. Putting aside fundamental questions about the Union’s economic competitiveness and sustainability, the European project requires belief if it is to survive. Belief from markets. Belief from electorates. The question now is whether each can keep pace enough to satisfy the other.